What leverage is in the forex market

Leverage is – a tool that allows you to make a lot of money with a small deposit. It is important to consider the risks when using it, because, in case of a mistake, a trader can quickly lose his money.

Why you need leverage

Leverage should be understood as an interest-free credit that a broker provides to a Forex trader. It is also called financial leverage.

If a player does not have enough funds to fully implement his strategy, he can borrow the required sum from a company that provides him with access to the foreign exchange market. As a result, the trader gets the opportunity to open transactions with that part of the lot, which would remain inaccessible with his own capital.

The coefficient of increasing the deposit due to borrowed funds can be different:

• some traders use a ratio of 1:10;
• others choose a value of 1:100;
• there are those who work with a leverage of 1:1000 .

The essence of these figures boils down to the following: for 1 dollar, a trader can borrow the sum that comes after the colon. If a ratio of 1:50 was chosen, then the user will have access to borrowed capital 50 times more than his deposit. That is, with $1,000 in the account, the investor will be able to manage the sum of $50,000.

The minimum and maximum leverage may differ from broker to broker. It can also change depending on the account type. Therefore, before starting work through an individual broker, you need to carefully study his trading conditions for different accounts.

Leveraged trading

To save your deposit, you need to understand how much money you will need to secure a position with the chosen ratio. A simple formula is used for this.

If you divide the position volume by leverage, you receive the sum that must be in the account to open a transaction.

We can take the example of a player with $6,000 on his balance sheet. He decides to trade the whole lot for the USD/CAD currency pair. The lot is 100 thousand units of the chosen currency pair. With a leverage of 1:100, you will need to allocate $1,000 for lot trading. The broker will take these funds as collateral (margin) until the transaction is completed.

This figure was obtained by calculations with the described formula: 100,000/100 = 1,000. The lot is divided by a leverage of 100 units and the result is 1 thousand USD of collateral.

The broker, taking $ 1,000 from the trader's account, provides him with credit funds of 100 thousand. That is, if the user starts with a deposit of, for example, $850, then he will not be able to trade 1 lot. His funds will not be enough to cover the margin.

The higher the leverage ratio is to deposit, the less money you need to trade one lot or any part of it. This crediting algorithm opens up opportunities for active trading for those who have a small deposit.

For example, with a leverage of 1:200, you will need $500 (instead of $1,000) for collateral for 1 lot. If a ratio of 1:1000 was chosen, then the margin will be $100.  The larger the leverage is, the lower the margin is.

A simple formula can be used to calculate the proper leverage.

To get more detailed information on the costs associated with a planned position, it is better to use special trading calculators. After indicating the leverage size, part of the lot and the currency pair, such programs display commissions, margin, point value, contract size and other important figures.

It is advisable to use the trading calculator of the broker with an open account – the calculation results will be maximally accurate. For example, the RoboForex broker's calculator looks like this:

If you approach trading correctly, then you can make a tangible profit with a small deposit.

The following situation can be taken as an example:

• a trader opens a position with a volume of 1 lot and a leverage of 1:200;
• in this case, the broker takes a collateral of $1 thousand and provides a credit of $100 thousand
• when working with the EUR/USD pair, 1 point on such conditions will be equal to $10.

If a trader makes a profit of 100 points, his profit will be $1,000. But with a 1-lot transaction, the risks will also increase.

To achieve stable results, you can reduce the risk and choose, for example, 0.3 lots. With such introductions, the player will receive a sum of $300 for 100 profitable points. The margin (sum of collateral) will be $174.   By closing 10 such transactions in a month, a trader will earn $3000.

As a result, a large leverage allows you to:

• Open large positions with a small account. So it makes sense to act if you have experience in trading. If the trading strategy is proven, then with a modest sum on the balance sheet and a large leverage, you can make a big profit for several transactions.
• Enter the market on several charts. When a trader uses from 2 to 5 currency pairs, he reduces the risks and increases the probability of making a profit. If 2 pairs do not work in plus, the remaining 3 pairs will make a profit.
• Build up positions gradually. The trader, not wanting to take big risk, starts with small lots and gradually increases his deposit. Due to leverage, transactions bring a noticeable profit. With the deposit growth, the player can choose a larger part of the lot and earn larger sums.

As a result, leverage allows you to work flexibly with the market: you can open transactions on different charts/timeframes and not limit yourself to one currency pair.

Risks of using leverage

When using leverage, you need to take into account the possibility of a currency pair drawdown. By itself, increasing the ratio will not enhance the point value. One step of the price movement will become more expensive if you choose a larger part of the lot. The larger the lot is, the faster the trader both earns and loses money.

When a player gets large sums at his disposal due to leverage, he is tempted to trade large volumes. The key risk lies here. The trader increases the lot, the point becomes more expensive, and the money in unprofitable trading disappears significantly faster than before. With large volumes, noticeable losses can be made even from stops alone. And if, using a part of the lot from 0.5, you open positions without a stop loss, then you can lose your entire deposit in a short time.

Traders who do not limit their losses to stops are periodically confronted with such a result as Margin Call – this is the forced closing of a transaction by a broker. Another name for such a measure is – Stop Out.

The position remains open as long as the funds in the account can cover the sum owed. In case of a strong drawdown, a large transaction volume works against the trader.

If the balance was $6,000, and the level of uncovered loss was $5,000, then the broker can offer the player to replenish the account to hold the position. If the transaction is rejected and goes further in the minus, there will not be enough money in the account to continue trading. In such a situation, the broker will make a Margin Call.

Brokers often do not wait for the complete emptying of the account, and close unprofitable transactions when 10-30% of the initial sum remains free money. There are companies that use Stop Out when the balance is 50% of the deposit.

Specific figures are usually indicated in the description of different accounts.

In order not to lose money, a trader needs to take into account possible losses from all open transactions. Sometimes players open many small positions, and more than 60% of them go in the minus. As a result, the total sum owed "eats up" the free margin, and the broker uses Stop Out.

For example, we can take a transaction with a leverage of 1:100 and a volume of 1 lot. The trader has $1,000 in his account. When choosing the EUR/USD pair, 1 point of movement of this asset will be $10:

• If the stop loss is set at 7 points from the transaction opening price, and the position goes in the minus, the trader will lose $70. This is 7% of the deposit for one transaction.
• With a stop of 15 points, losses will be $150. This is 15% of the deposit. If there were 3 such transactions, the deposit will be reduced to $550. That is, the losses will be 45%.
• If there are no stops, the balance can be zeroed by one unprofitable position, which will pass 100 points.

And all this is due to the choice of a large lot.

By choosing a ratio of 1:100, but opening a transaction for 0.1 part of the lot, the trader will receive a point value of $1.5. In this case, 15 points of the closed stop will bring a loss of $22.5. With a deposit of $1,000, such a risk is acceptable – the trader will not be able to lose money quickly.

Result: – you need to work carefully with the volumes that have become available with the help of leverage.

Additional costs

In addition to direct losses, you need to take into account that part of the deposit will go to pay the spread and broker commissions. The higher the leverage is, the more these costs are.

If we take the example of EUR/USD with a leverage of 1:100 and a volume of 0.1 lots, then the spread will be from 0.10 to 1.5 USD. The exact figure depends on the broker and the chosen account.

With a spread of $1.5, 10 such withdrawals are enough to take $15 from the balance. If a trader chooses a leverage of 1:200 and a part of a lot of 0.3, then the spread will be $4.5. You also need to consider swaps (Swap) – a fee for rolling over an open position to the next day.

All this can be calculated using the leverage calculator. By obtaining accurate figures, the trader can determine the average sum of additional costs.

For stable trading, you need to control risks and, above all, to practice your skills in working with the foreign exchange market. Then leverage will help you to increase your small deposit and start making good money.

And we recommend all our visitors to continue studying our school, where a lot of useful information about the Forex market is presented. In addition, you can buy or get free programs from us that greatly simplify the trading process and increase your profits.